Commentary

Let the Greeks vote in a referendum

Commentary: As in Iceland, a vote would concentrate creditors’ minds

By

MeghnadDesai

LONDON (MarketWatch) — As the euro drama slides into melodrama and then possibly into farce, Greece should learn from the example of Iceland, which went bankrupt two years ago. Like Ireland, Iceland ran into problems with its private banks, which built up excessive liabilities by offering an above-market interest rate on deposits and then crashed when Lehman Brothers went down.

The debt — which were the deposits taken by the banks operating abroad — was left with the Icelandic Treasury. But in a referendum the Icelanders voted to renege on the debt and forced the creditor countries — mainly the U.K. and the Netherlands — to renegotiate.

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Not being in the euro, Iceland could let its currency depreciate — a painful exercise, but one that lets individual citizens make their own adjustments to inflation. Now two years on, Iceland is on track for annual growth above 2% this year and next after a cumulative 10% fall in output in 2009 and 2010. Iceland has returned to the international capital markets and can borrow at 5% — a rate the Greeks (as well as the Irish and the Portuguese) can only dream of.

There is a lesson for the euro area here. Not every creditor deserves a break. They should have known it was risky to lend to Greece. Let them bear the cost. I believe Greece should hold a referendum on whether its citizens are willing to pay back the debt. That should concentrate minds — both in Greece and among the creditor countries — and might make a contribution to resolving the issue.

A referendum would certainly be better than the other options that are feared — a revolution or even a military coup. But Greece is used to such shocks — and has a long history of reneging on its international obligations. The Papandreou government is fast running out of options. It’s hoping for respite from privatizing many Greek assets. But this is a tricky political decision for an ostensibly Socialist Party. Even if the government decides to sell, it may not get its hands on the money for while. And a fire-sale will be counter-productive. Read our full report on Greece’s options.

The tragedy is that even if Greece eliminates the deficit with great fiscal pain, its debt would only stop rising, not disappear. The debt needs to shrink to at least half its current level of 157% of gross domestic product.

Meghnad Desai: I believe Greece should hold a referendum on whether its citizens are willing to pay back the debt.

Germany went through a decade of austerity after it absorbed the dysfunctional East German economy. The Germans succeeded in pulling through with their economic health restored. That’s why they have no sympathy for the Greeks, who they think are lazy, retire too early and pay no taxes.

Tragedy No. 2 is that the International Monetary Fund has chosen the wrong candidate as managing director to fix the euro crisis. French Finance Minister Christine Lagarde’s backers said only a European can heal the euro. This argument is not only racist; it is also wrong. Euro decision-makers — including Lagarde — have tried to deal with each problem euro country one by one. And one by one they have failed.

France and Germany, the euro’s leading powers, have different views. France wishes to tie economies into a tighter control grid with budgetary co-ordination under centralized oversight. For a long time Germany wanted all euro members to be as prudent and fiscally responsible as the Germans. Then it switched priorities to saving German banks with big positions in euro-area debt. Now German Finance Minister Wolfgang Schäuble says that he wishes restructuring in the form of write-downs for private bondholders.

Next steps will not be simple. Jostling for position are the European Commission, the ECB, the Council of Ministers, the Euro-Group and then, on top, the IMF. Schäuble’s resolve on making private creditors pay has been watered down by Chancellor Angela Merkel after meeting President Nicolas Sarkozy. Of course, Greece should never have been allowed to join the euro. But then political considerations demanded maximum membership. Gross irregularities in Greece’s national accounts were ignored.

Now everyone is dancing to the Greek fiddle. Wait for the Greek people to speak. The music may suddenly speed up.

Meghnad Desai is chairman of the advisory board to the Official Monetary and Financial Institutions Forum. Desai is a professor emeritus at the London School of Economics, and a former Labour Party leader. This article was originally published in the July issue of the OMFIF Bulletin.

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